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Monday, October 24, 2016

Crazy Mortgages

For anyone who got their first mortgage more than a decade ago, the reality of getting into today’s housing market can be an eye-opener. In describing the effects of the latest new government mortgage regulations, Rate Spy writes

“Today, someone with 10% down who makes $50,000 a year can qualify for a $300,000 home purchase. That hypothetical maximum mortgage amount will plunge 18% to $246,000.”

Mortgage experts have become desensitized to such numbers, but to me they look like there must be a typo. Someone earning $50,000 per year can get a $300,000 home with only $30,000 down! That leaves a mortgage of about five and a half years of gross earnings. It seems crazy for someone to dig such a huge financial hole. Dropping this mortgage size to about four and a half years of gross earnings isn’t enough better.

Rate Spy goes on to write

“This one regulation alone could shut out more buyers from the market than possibly any of the prior rule changes.”

Good. I’d be horrified to learn that one of my sons made such a huge financial mistake.

I have no opinion yet about other criticisms of the government’s new mortgage regulations. However, reducing the size of mortgage people can get for a given income is sensible. As I frequently tell my sons, renting is better than becoming a slave to your mortgage payment for decades.

Michael no offense but I believe you are overblowing things when you say, "Someone earning $50,000 per year can get a $300,000 home with only $30,000 down! That leaves a mortgage of about five and a half years of gross earnings."

For one thing, lenders do not approve borrowers who exceed the government's establish debt ratio limits. These limits were already restrictive before the new rules were announced.

Second, you are measuring debt to income in today's dollars for a 20-25 year commitment. Not only will the borrower's income increase significantly over time, but time value of money will make their debt payments decline in real dollars. In other words, a $1500 a month mortgage payment today is only $1350 in real terms when the borrower renews in 5 years.

Lastly, price appreciation is at least 2% annually over the long term. In some places it's much more, despite all the crash predictors 8 years ago. So you have an asset that rises in value most of the time and serves as a forced savings account.

Frankly, calling home buying "a huge financial mistake" is an unsupported argument in this post. I've always had an issue with personal finance commentators making such blanket statements. In fact, it has proven bad advice to dissuade most qualified buyers from home ownership so long as their discretionary income allows for retirement savings.

@Anonymous: I disagree on almost all points. The debt ratio limits are not at all restrictive; they are too lax and allow people to bury themselves in big mortgage payments. Counting on large income increases over time is very risky. It's better to wait until income rises instead of pre-spending future income whose growth may disappoint. A 10% decline in the real value of payments in 5 years is not enough to reduce risk sufficiently. Counting on unpredictable price appreciation means nothing to someone who hopes to continue living in the home. I stand by my statement that buying too much home is "a huge financial mistake." When people reach for too much home, they often can't afford retirement savings or even necessary repairs.

Absolutely not! Second last paragraph of Anonymous poster's inference that housing is a guaranteed good investment. After interest, maintenance, property taxes, possible rate increases, possible property value declines, insurance, and lost opportunity cost (of what the downpayment and regular payments could have been generating elsewhere), that 2% looks mighty feeble.

I agree with James--I cannot fathom why people are in such a rush to push "kids" (most still with student debt) right into $600K+ of debt when they should be enjoying their lives.

The following comment from an anonymous commenter seems to have disappeared:

______________

When you say the debt ratio limits are "not at all restrictive," what does that actually mean?

Are you arguing that the government's 42% total debt service maximum is too high? Based on what? Is it too high for everyone? Or just some people? Can you make such a blanket statement not knowing each buyer's financial circumstances?

You imply a $270,000 mortgage is not suitable for a $50,000 income. That is a $1195 a month payment plus property tax and maybe condo fees. Where can you get a rental for that in a big city?

This is not only about buying " too much home." This is about not generalizing and saying the whole system is flawed because some people don't meet your personal lifestyle beliefs. A $1195 a month mortgage is absolutely not "too much home" for someone who makes $50,000 a year and it never has been. _______________

Your argument seems to be that the maximum debt service ratio should be set as high as necessary so that it doesn't restrict anyone unreasonably. So, the fact that 42% is unreasonable for almost everyone is immaterial if there is even one person who can handle it. I disagree. Taxpayers provide guarantees against mass mortgage defaults. It's the government's responsibility to look out for taxpayer money.

But I tend to look at this from an individual's point of view. Regardless of the government's rules, young Canadians should not blindly trust that lenders will only lend reasonable amounts of money. If they understood what they were getting into, many young people wouldn't bury themselves in mortgage debt.

I can easily find a rental for less than $1195 + property taxes + condo fees + cost of upkeep. Anyone who actually adds up all the real costs of ownership will find that renting is almost always much cheaper.

Whether or not $1195/month is unreasonable for someone making $50k/year to pay is one debate. But what will happen if that payment rises when interest rates rise? Being conservative with mortgage size is a sensible personal policy.

@Anonymous: For most people under 35, I'd say a reasonable limit on debt to gross income ratio (assuming almost all the debt is a mortgage) is about 2.5. However, this should drop over time as people get older and use up their human capital. I realize that this prices many people out of buying homes, but that's the idea. It's not a good idea to bury yourself in debt.

I am shocked as well at the mortgages folks get. It's not nearly as bad as it was a couple of years ago. But it's still disconcerting how much the government allows. Hopefully I won't have to take out another mortgage in my life. I'm not interested in the bank owning anything else of mine.

@Mustard Seed Money: I agree. The government has conflicting goals here. They want to be seen as encouraging people to realize their dreams of owning a home. At the same time, they don't want runaway prices followed by a crash and the sudden onset of mass mortgage defaults. Being debt-free is a good feeling.

I wonder if it would make a difference if young borrowers could be made to understand that when they go into debt, that they are not borrowing from the bank...they are borrowing from their future selves.